FINANCIAL IT SYSTEM SUPPORT

Financial IT development projects took a massive boost in the mid-1980s following “Big Bang”. Open systems running on common client-server architecture became the industry standard at the beginning of the 1990s and system choice for banks and fund managers increased. There are now numerous vendors, e.g. Algorithmics, Barra, Erisk, Misys, Reuters, Sungard, who will be happy to entertain you. The hardest job is to select which one. Finding the right supplier can provide real business value-added service at a competitive price. Technology has enabled a huge number of private investors to take part in whatever investment at a touch of a button. This has resulted in an unprecedented widening of the clientele within global exchanges. But, technology increased the potential for IT and systems failures, commonly lumped into the catch-all “operational risk”. Some banks have met spectacular failures, or have been taken over by more capable and risk-aware banks.
Choose substance and not style in risk management systems. Many system vendors promise to provide you with the “best” systems for every business line. We must choose the “best” IT systems supplier to design and install our specific business environment.
Good use of IT is not about buying fancier computer boxes and designing jazzier websites. All computer-based financial modelling tools and complex IT systems promise to help you. The Loss Database for Basel II is one product that holds a lot of potential. The question is whether it will deliver. The key to success lies in its project implementation.
The Basel II Loss Database project
The new Basel II banking regulations are geared to raising the overall level of risk management in banking and fund management portfolios. Basel II will enable regulators to request advanced operational risk-managed financial institutions to set up and maintain the Loss Database. It has two business drivers, one a mandatory requirement and an optional “nice-to-have”.
First – all financial institutions wishing to have the status of an “Advanced” risk-managed company must comply with the Basel II. One of the requirements is the formation of the Loss Database.
Second – there is the goal of detecting consistent patterns of loss, and extrapolating from the data to predict the likely level of future business losses.
The ultimate objective is to reduce their level of losses and increase the predictability of the remaining losses. The downside risk of this project is an expensive business and an IT white elephant that does not meet business expectations.
A large global bank can have an expensive loss database, both in terms of number and value of loss items, plus the huge project costs of creating the database. They cannot afford to get it wrong because to do so would be both costly and embarrassing. Backing out a failed loss database project from all global branches would also be a high-profile noticeable loss (compare: Reputational risk).
An operational loss database, driven by the desire for good management or by the regulators, represents a large investment. An empowered band of financial specialists can reap real rewards for the company, supported by IT systems staff to “drill-down” within the loss database. This data-mining involves finding out lines of causality for:
who
when
how much was lost
how much could have been lost
why it all happened in the first place.
Loss databases will have to prove themselves against resilience-based approaches. These data will be analysed time and time again under different data-mining angles. The real test will be that of continual testing and review for cost-benefit analysis.
The loss database is a potentially good corporate risk management tool, but, it is likely to fail where it attracts little support within the corporation. Loss data are input for risk management decision making, and it needs a lot of massaging into acceptable reports before it can help to formulate director-level actions. The initiative stands or falls on whether top management supports and funds it.
The benefits are easier to predict than the costs. An advanced-certified operational risk-managed bank will have lower Basel II regulatory capital charges because its risk management processes are highly developed and evaluated as a lower overall risk. From previous regulatory examples within credit risk, a bank could find its regulatory capital reserve falling by some 6 %.4
How much this will translate into similar savings for OpRisk is to be decided by the regulators interpreting the Basel II guidelines.
Risk appetite becomes more directly linked to risk offer, but risk appetite is also covered by Basel II regulatory capital. Risk support systems alert the danger of capital becoming inadequate to cover expected losses.
The loss database business rationale may be a search for lower risk ratings and knowledge data-mining, forced on them by the regulator. The compliance “Big stick” approach of the regulator may be better at explaining the need for the database, instead of the more complex business cost-benefit analysis.
Losing money has never been in the interests of a bank, nor of its clients. Yet banks and investment funds continue to lose money without knowing where or why. There is some hope that this integrated database, linked to advanced modelling tools, can help make investing less risky. It will most likely be a complex and expensive project to set up, mainly because of the complexity and size of the data collected.
The formation of a complex loss database is a knowledge management structure that we are actively constructing. It requires a lot of data and system integration to link the disparate elements in a global bank. Some call this risk management system a “data warehouse” where information is packaged into one compatible format for analysis (see Enterprise application integration – EAI). The benefits are the harnessing of market intelligence to understand: who, when, how and how much money has been lost. Then, we can reinforce risk management procedures to avoid such a loss recurring, or to reduce the loss when the hazard strikes again.